The work to transition the utility compensation model from traditional to performance-based ratemaking (PBR) is giving rise to a range of hybrid models, though PBR advocates continue to push for a more transformative regulatory framework.

Traditional cost-of-service regulation (COSR) allows utilities to include a shareholder benefit, typically around 10%, to regulator-approved customer rate increases for infrastructure investments. PBR would incentivize utilities to meet policy goals and customer demand through actions that don't include capital expenditures.

"Using performance incentives to transform the utility business model is a response to rising capital costs, weakening revenues and disruptive new technologies," Pace Center for Energy and Climate Executive Director Karl Rabago told Utility Dive. "Incentives can drive market transformation if they give utilities new earnings opportunities."

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"It's not possible to fully break the link between the utility's actual cost of service and the ratemaking mechanisms put in place to recover the cost of service."

Doug Horton

Vice President for Distribution Rates and Regulatory Requirements, Eversource Energy

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With growing penetrations of variable renewables, distributed energy resources (DER) and energy efficiency, utilities see the opportunity to respond to the conditions Rabago described through PBR mechanisms. Those mechanisms better align utility incentives with public policy and customer demand, utilities and others told Utility Dive.

But efforts around the country to revise traditional regulation, as described in part one of this series, may not lead to the envisioned distribution system platform open to third-party providers and peer-to-peer energy exchanges, some stakeholders said. Instead, PBR concepts may be the leverage needed to transform traditional regulation and deliver more of what customers want and policymakers require, they told Utility Dive.

Barriers to breaking tradition in New York

As the traditional utility paradigm shifts, many utilities see benefits from PBR components, but do not see a complete transformation of the traditional business model as practical.

"It's not possible to fully break the link between the utility's actual cost of service and the ratemaking mechanisms put in place to recover the cost of service," Doug Horton, Eversource Energy Vice President for Distribution Rates and Regulatory Requirements, told Utility Dive in an email. Severing the connection of costs and rates could lead to "customers paying more than they should, or the utility not recovering what it should."

Eversource welcomes a version of PBR that shifts the paradigm, but does not change the fundamental business model, Horton said. 

The utility's new five-year plan in Massachusetts will reduce the cost of service, giving customers rate stability "that would not have been achievable under traditional cost-of-service regulation," he said.

Traditionally-regulated service costs will be met through energy efficiency and small revenue adjustments instead of through large rate case revenue adjustments. And Massachusetts is expected to add PIMs that deliver more customer benefits, like technologies that make the distribution system more flexible, according to Horton. 

New York set out to drive a much bigger change in the way utilities are compensated than Massachusetts, but has so far gone only one step further toward transformation, by including PIMs.

The state's Reforming the Energy Vision (REV) strategy was intended "to evolve the utility business model," Energy Innovatio​n (EI) Director of Electricity Policy Mike O'Boyle told Utility Dive. Its 2014 goals included a distribution system platform open to third-party providers and peer-to-peer energy exchanges.

So far, REV has enacted utility compensation for expenditures on non-wires solutions and an earnings adjustment mechanism (EAM) for energy efficiency expenditures. But the EAMs, layered on to New York's COSR, have "gotten away" from the REV's early ambitions, a Director at Advanced Energy Economy (AEE) Danny Waggoner told Utility Dive.

Though they reward regulated utilities in the state for energy efficiency performance, they are not "high-level outcome-based metrics on overall energy usage and peak demand," he said.

Consolidated Edison, the state's largest utility, disagrees. "We delivered more than our maximum energy savings goal with our Energy Efficiency programs in both 2017 and 2018. That's a clear benefit for customers," utility spokesperson Allan Drury emailed Utility Dive.

PBR "was not intended to be a replacement" to New York's traditional COSR, Drury said. "Utilities continue to earn a return on their investments."

The PBR vision fades in New York

REV's shortcomings left utilities without adequate incentives to go farther, AEE's Waggoner said. Because the New York commission initially limited the size of EAMs, they did not provide the alternative earnings needed to spur significant change in the COSR, but PBR with well-designed PIMs can work, he said.

Metrics must be precise so utilities can trust that compensation will be accurate, and incentives must sufficiently compensate utilities for reduced earnings and increased risk. "Earnings from rate base is a sure thing, but there is risk in performance incentives, and utilities need to be rewarded for taking on that risk," he said.

The REV process also expanded into policy issues that had "more near-term business impacts" for stakeholders, like the costs and benefits of rooftop solar and the value stack of battery energy storage, he added. "That left a lot of friction in the process."

REV "is bogged down," EI's O'Boyle agreed. "It's nowhere close to the vision for transformational change that was articulated in 2014. It exploded into so many different proceedings, like value of DER, and did not arrive anywhere."

The process "has been thoughtful but gradual and that has been frustrating for stakeholders, but utility regulation is a slog," O'Boyle said. But COSR "is not delivering and we have to try new things."

Efforts in Minnesota and Hawaii

Newer PBR efforts in Minnesota and Hawaii have gone in divergent directions. Minnesota stakeholders tentatively accepted the inclusion of PBR components into traditional regulation, while Hawaii stakeholders are still holding out for a larger transformation.

Minnesota's stakeholder-led consensus called for a formal proceeding to study ways PBR could improve COSR. In Xcel's filing, VP Aakash Chandarana proposed that PBR be used to improve utility performance through shaving peak demand, shifting load and integrating DER.

Hawaii's May 23 Phase One order "stayed true" to the Hawaii Public Utilities Commission's "stated approach of gradualism," Hawaiian Electric Companies VP for Regulatory Affairs Joseph Viola told Utility Dive in an email.

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"A 'no regrets' element in PBR is clearly identifying utility performance objectives, because guidance on what the commission sees as public interest priorities can be a really powerful motivator for utilities."

Mike O'Boyle

Director of Electricity Policy, Energy Innovation

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The utility supports "regulatory changes that increase predictability in revenues, establish objective performance measures and offer reward opportunities for achieving objectives," Viola said. But equally important is the commission's recognition "of the utilities' financial integrity as a foundation for sustained achievement."

But other stakeholders in Hawaii say phase two of the proceeding could completely reshape the utility business model.

"Phase Two will determine how decisively we will break from the old cost-plus system," Earthjustice Attorney Isaac Moriwake, who represented environmental group Blue Planet in the proceeding, told Utility Dive in an email.​

The practical PBR

PBR is "not all or nothing," it is "a set of tools," including PIMs, that may not be the REV vision but can drive vital power system change, O'Boyle said.

"A 'no regrets' element in PBR is clearly identifying utility performance objectives, because guidance on what the commission sees as public interest priorities can be a really powerful motivator for utilities," he said.

To more effectively use PIMs, the Rhode Island Public Utilities Commission is developing a set of PIM Principles — guidelines that shift the burden of proof from regulators to the utility. Through justifying the need for an incentive, utilities are tasked with providing evidence that PIMs are the best way to meet customer demand or adhere to policy.

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"It is probably not possible to change the existing model quickly, but the New York REV has shown a commitment to animating DER markets with PBR that has provoked change by utilities."

Karl Rabago

Executive Director, Pace Center for Energy and Climate

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"We want to set out the structure and the evidentiary framework and have the parties show us that a performance incentive mechanism is the right tool to advance that particular public policy," Commissioner Abigail Anthony, who proposed the five draft principles, told Utility Dive.

The principles are not an endorsement of PBR, according to Anthony's proposal. PIMs can supplement COSR.

Their purpose is to reward a utility for performance if it does not "already have a financial incentive through traditional regulation," she said. "That is the first threshold for an acceptable PIM."

To prove the need for a proposed PIM, utilities will likely need to make proprietary information available to regulators and rate case interveners, which eliminates a major challenge to the commission and stakeholders — obtaining high quality data.

"If we demand better data and utilities have something to gain from making it available, we will start to see [that data]. That is a key value of the principles," said Anthony.

Synapse Energy Economics has "struggled with utilities in a lot of different jurisdictions to get data good enough to set realistic performance targets, rewards and penalties," Melissa Whited, a principal associate of the consulting firm, agreed. "A 180-degree business model transformation will not come anytime soon, but the gradual shift toward performance-based revenues for purposes like obtaining data will continue."

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"Adoption of new technologies that serve their systems and their customers should drive market transformation, but utilities seem to need incentives to change. PBR offers those incentives."

Karl Rabago

Executive Director, Pace Center for Energy and Climate

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As a former member of the Public Utilities Commission of Texas, a rate case expert witness and a participant in New York's REV, Pace's Rabago has seen PBR used for cynical and altruistic reasons, he told Utility Dive.

"It is probably not possible to change the existing model quickly, but the New York REV has shown a commitment to animating DER markets with PBR that has provoked change by utilities," he said. "That has happened before with the emergence of other disruptive ideas like smart grid and integrated resource planning."

Because utilities tend to be cautious, "each wave of new technology sends advocates back to the toolbox for incentives to get utilities to adjust their attitudes and their spending," Rabago said. "Adoption of new technologies that serve their systems and their customers should drive market transformation, but utilities seem to need incentives to change. PBR offers those incentives."

In the past, environmentalists supported deregulation because "it was a better way to get utilities to build more energy efficiency and renewable energy," he said. "It seemed that the possibility of deregulation would drive the change faster than beating our heads against the traditional utility business model. PBR is serving the same role."

Driving change through prescriptive regulation is "more difficult and slower than talking PBR, PIMs and metrics and getting utilities to respond to earnings opportunities," he said. Though REV didn't pan out exactly as intended, "having $1 billion on the table put the ConEd energy efficiency program on steroids."

No set of PIMs can "bribe a utility into being something fundamentally different," Rabago said. But using PIMs to incrementally move a utility toward new technologies "can reduce the friction of transition until, finally, the utility culture changes."